Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Sunday, 31 January 2010

Obama scratches around amongst the selection of strange job creating schemes served up to him by economicaly illiterate conservatives. Tax credits are unfortunately flavour of the month.

These involve rewarding each employer in proportion to the increase in numbers they employ. This idea gets re-invented with monotonous regularity.

The idea was popular in the UK about thirty years ago and was advocated by Richard Layard (former Prof of Economics at the London School of Economics). Anyone wanting to look at the relevant literature will find some of it by Googling “marginal employment subsidy” because the latter was the phrase used to describe the idea in those days.

Two of the current leading advocates of the idea in the U.S. are messers Bartik and Bishop.

Layard & Co produced a variety of ideas as to why the tax credit idea works. Bartik and Bishop simply add to this bright and varied selection of alleged explanations. In other words the advocates of the tax credit idea cannot agree amongst themselves as to why the idea works.

Bartik and Bishop’s explanation seems to be that a 1% cut in wage costs brings a 0.3% rise in employment. Far from being an argument for tax credits, this is a good argument for NOT implementing tax credits because the 0.3% effect is feeble compared to a much simpler alternative: simply spending the money on a straight increase in aggregate demand.

To illustrate say 1% of GDP is devoted to tax credits. Assume wages make up 70% of GDP (this figure actually varies over the years between roughly 60% and 80%, but let’s say 70%).

The expansion in employment that results from the above will be 1/0.7 x 1% x 0.3 = 0.42%.

Now suppose one uses the money to effect a straight rise in aggregate demand (say an increase in government spending on roads, the military, schools, etc). In this case the rise in employment will be 1% x 0.7 = 0.7%. Well that’s a better result (if I’ve got it right). And there is none of the time consuming bureaucratic nonsense involved in trying to ensure that employers are not abusing the system (e.g. “sacking” staff and “hiring” them a few weeks later with the assistance of the subsidy).

In truth, even the above “anti tax credit” argument is nonsensical as the equivalent pro-tax credit argument. This is because both arguments rely on the flawed “value for money” argument or “bang per buck” argument. Bang per buck often makes sense at the micro economic level. At the macro-economic level it frequently becomes a nonsense.

The tax credit idea was implemented in the U.K. about thirty years ago, but was limited to small firms. The scheme was called the “Small Firms Employment Subsidy”. It was abandoned as quickly as it was set up.

Note added 1st Marth 2010: Two papers from about 30 years ago on the subject: http://www.jstor.org/pss/2231655 and http://www.jstor.org/pss/2233436

Thursday, 28 January 2010

It is currently popular to claim that reducing the deficit or repaying the national debt too early will hinder recovery. The argument presumably being (though this rarely seems to be spelled out) that repaying this debt involves collecting taxes (or reducing government spending) so as to get the funds with which to do the “repaying”. And collecting taxes/cutting public spending is deflationary. Therefore this policy will hinder the recovery. This is a grossly over simple and flawed argument.

The basic flaw.

The basic flaw in this argument is that while the above policy is deflationary, this can perfectly well be counterbalanced by a very simple reflationary policy: printing the necessary extra money. It is true that there are book keeping entries in central banks corresponding to this extra money which are classified as “debt”. But this is one big nonsense: this is not debt in any normal meaning of the word.

However, that is still an over-simplification of the issue. So let’s look at the national debt in more detail.

The two different types of national debt.

“National debt” is commonly regarded as some sort of homogenous lump. It is actually made up of two very different forms of debt, which have very different characteristics, as follows.

The bulk of the national debt is of what might be called the “Keynsian borrow and spend” type: that is, money owed by government to people or institutions. In contrast, there is a smaller proportion (roughly a quarter in the UK, as far as I can make out) which is not of this nature at all: it is money owed by the Treasury to the Bank of England. This is not “national debt” in any real or proper sense of the phrase. Effectively, this is simply a book keeping entry or a pile of gilts corresponding to the additional money that has been printed during the recession. This is an IMAGINARY debt.

A further complexity is that national debt is owed partially to British nationals and partially to foreigners. Let’s look at foreign creditors first.

Foreign creditors.

Repaying foreigners involves a real standard of living cut for UK citizens: this is a transfer of real wealth to foreigners. This is simply the reverse or counterpart of the initial standard of living BOOST which occurs if one borrows with a view covering the difference between one’s spending and income where the former exceeds the latter.

However, this standard of living cut DOES NOT preclude full employment or recovering from the recession. The only barrier to full employment is inflation. I.e. this repayment of foreign creditors which will doubtless have a deflationary effect can perfectly well be counter balanced by money printing and/or interest rate cuts (or abstaining from interest rate increases).

(Strictly speaking there is another possible constraint on achieving full employment, which might occur where other countries reflate to an inadequate extent. Were the UK to reflate too much under these circumstances, the result could be a catastrophic collapse in the pound rather than the controlled reduction in its value, which has actually taken place (and congratulations to the authorities for at least getting this one right). Samuel Brittan I seem to remember referred to this “pound” constraint in a recent article in the Financial Times. However, this “pound” constraint exists ANYWAY: that is, it is not a problem specific to attempts to reduce the national debt. Thus this point is not really relevant here.).

Creditors who are UK nationals.

As regards repaying creditors who are UK nationals or institutions, and in relation to the “borrow and spend” part of the national debt, there is a slight problem: to what extent is the well known problem with borrow and spend, namely “crowding out”, a real problem? Let’s take one extreme first and assume that crowding out is so serious that borrow and spend is totally ineffective so far as reflating an economy goes.

In this scenario, borrow and spend has no effect. Thus the opposite – paying back the debt – has no effect either !! The debt can be repaid with impunity: that is, there will no deflationary effect from repaying the debt!

Now let’s take the opposite extreme and assume that crowding out has no effect. In this scenario, borrow and spend is highly effective, and likewise, repaying the debt will be deflationary. But is this a big problem? The answer is no, and for the following reason.

If crowding out has no effect, this implies that borrow and spend involves taking idle bank balances, and spending same, which has a reflationary effect. Thus the reverse of this operation must involve repaying debt to the latter bank balance owners, who then (as before) do little or nothing with said money (for reasons best known to themselves).

So what’s the solution to this monstrous non-problem. The answer is to print even more money: but please, please DON’T hand it to “Wall Street”. Hand it “Main Street”: the latter is much more likely to spend the money, which will stimulate demand and create jobs.

The net effect of the latter operation is to convert a chunk of the national debt which is real debt into a chunk which is better described as imaginary debt. In other words this is an effective reduction in the national debt.

Having considered two extremes in relation to crowding out, the truth is doubtless somewhere between the two extremes, neither of which are a big problem. Thus a position somewhere between the extremes is presumably not a problem either.

The imaginary portion of the national debt.

The above paragraphs dealt the REAL portion of the national debt: the portion that involves a debt, in the normal sense of the word debt, owed by government to people or institutions.

In contrast, as mentioned above, there is the portion corresponding to recent monetary base increases. There is a very simple way of getting rid of this portion: just tell the governor of the Bank of England to tear up the relevant gilts!

This portion of the national debt is ONE HUGE NONSENSE ! Or as Hilliger (p. 22) put it, this is a “merry go round”.

However, there is SOME SENSE in preserving this nonsense: it helps keep a distinction between a central bank and a government. Giving politicians DIRECT access to the printing press is certainly dangerous.

Conclusion.

The rate at which we go for “fiscal consolidation” or “repaying the national debt” or “reducing the structural deficit” is independent of, or can be made to be independent of the reflationary/deflationary stance that government and central bank want to take, bar a couple of caveats, as follows.

To the extent that a country repays foreign creditors, this involves a standard of living hit, but it NEEDN’T involve slowing down the speed of exit from the recession (in the sense that the speed with which we revert to full employment needn’t be hindered).

Second, reducing the national debt probably to some extent involves replacing this debt with an expanded monetary base. The latter can be construed as “national debt”, but this use of the word debt is pretty nonsensical.

Wednesday, 27 January 2010

The conclusion at the end of Part II (see below) was that there is no very obvious logical niche for “make work”, because a better alternative would seem to be to subsidise those concerned into work with existing employers (public and private sectors).

The Jefes system in Argentina and the UK’s “New Deal” involve (amongst other things) something along the above lines, that is, temporary subsidised work for the unemployed with existing employers.

The UK’s New Deal is limited to people unemployed for about six months, while in contrast, a system in operation in Switzerland a few years ago had no such time limits.

So where is the economic logic in temporary subsidised work for the unemployed?

One argument is “hysteresis”, that is the idea that when people are unemployed for too long they lose skills and give up looking for work. This idea has an obvious “common sense” appeal, however various researchers have claimed that hysteresis is a non-existent or weak effect. (See here and here.) If there is anything in hysteresis one has to wonder how women who leave the workforce for a decade or more to bring up a family manage to re-enter the world of work at the end of this period.

There is actually a better argument for temporary subsidised work with existing employers, and it is thus.

Given falling unemployment, the worth or productivity of each succeeding person hired tends to fall. This is for reason mentioned in Part I: the increasing difficulty of matching available skills to vacancies as unemployment falls. Or in economics jargon, the marginal net revenue product (MNRP) of labour falls, given falling unemployment.

Note that this is a MACROECONOMIC phenomenon. I.e. this NOT to be confused with the well known MICRO ECONOMIC phenomenon whereby the MNRP of labour falls within a particular firm given an expanding workforce, while the volume of other factors of production employed are held constant.

Next, note that when MNRP falls far enough (approximately to the minimum wage, union wage, or whatever) employers will then tend to reject dole queue labour and will tend (wittingly or unwittingly) to poach labour from each other. And that spells inflation.

Next, note that the low productivity of EACH UNEMPLOYED PERSON on the dole queue given low unemployment is a TEMPORARY phenomenon. That is, sooner or later, a job turns up to which each person is suited, and at which they will be able to earn at least the minimum wage, or in some cases, several times the minimum wage.

So the solution to the problem is? . . . . . . A temporary employment subsidy, that is, a system that subsidises each unemployed person into a temporary job UNTILL a more suitable job appears.

Also, note that the latter solution to the problem is more or less what market forces will do automatically in a totally free labour market. And by “totally free labour market”, I mean a market with no artificial interference in the form of minimum wage laws, union wage rates, unemployment benefits, and so on.

This is NOT to argue that these “interferences” are unjustified. The point is simply that in a perfectly functioning free market (a very theoretical construct, of course) there is NO unemployment. Thus, at least on the face of it, any system which is similar to such a free market scenario (like the temporary employment subsidy advocated here) ought to reduce unemployment.

Tuesday, 26 January 2010

Having demolished “government as employer of last resort” schemes in Part I (see below), I’ll try building something from the rubble. (These schemes are referred to as “WPA” here.)

As shown in Part I, efficient WPA schemes amount to the same thing as normal public sector employers. The inference would seem to be that one might as well allocate WPA employees to existing public sector employers – though of course the obvious problem is that there would be far more WPA employees than existing public sector employers could cope with.*

But there is a solution to this problem, and it comes from a flaw in the popular claim by WPA enthusiasts that WPA is not inflationary, whereas increasing demand IS.

As pointed out in Part I, WPA comes into its own in dealing with unemployment where the latter is relatively low (at or near NAIRU, for those who want to invoke NAIRU).

Given low unemployment, the factors of production needed by WPA other than unskilled labour (i.e. skilled supervisory labour, capital equipment and materials) a CANNOT BE NICKED FROM THE EXISTING ECONOMY.

This is because we have assumed low unemployment: a scenario where the existing economy is already working AT CAPACITY. Any additional demands for materials or equipment (or removal of skilled labour) will be inflationary.

Indeed it is perfectly reasonable assumption that where public sector WPA scheme results in a given shortage of a given selection of “other factors of production” (OFP), the inflationary effect will be exactly the same as where an increase in demand results in the same OFP shortage. I.e. THERE IS NO DIFFERENCE IN THE INFLATIONARY EFFECT, GIVEN A FAIR COMPARISON, AS BETWEEN EXPANDING THE PUBLIC SECTOR AND EXPANDING THE PRIVATE SECTOR.

Having concluded above that WPA employees might as well be allocated to existing public sector employers, the paragraphs immediately above would seem to suggest that this conclusion can be extended to the private sector: i.e. the conclusion would seem to be that WPA employees ought to be subsidised into work with ALL employers (public AND private sector) – with “WPA” as such disappearing.

(Indeed, the Jefes program in Argentina, a program which current advocates of WPA always like to quote, actually allocated a proportion of those concerned to subsidised employment with private sector employers. See bottom of p.7 here.)

But where is the economic logic in this? Or put another way: having subsidised WPA employees into work with existing employers, what is the difference between the two sets of employees, “normal unsubsidised” and “subsidised”?

Answers in Part III in a day or two.

* Indeed, and in this connection, we have had the disgraceful and farcical spectacle of State Governments in the U.S. (and other local authorities in other countries) sacking existing public sector librarians, teachers and street sweepers etc, while governments (central and local) have been producing a bizarre selection of WPA type “shovel ready” schemes of one sort or another. To add insult to injury, no doubt a few of the "shovel ready" jobs involved librarianship, teaching and street sweeping! It would have been a darned sight better to have spent the “shovel ready” money making sure existing regular public sector jobs were not destroyed by the recession, would it not?

Sunday, 24 January 2010

I have no idea how many make work schemes have been implemented and abandoned over the last few centuries. Perhaps hundreds. The WPA in the U.S. in the 1930s was one of the biggest such schemes. But there is a logical flaw in these schemes as follows. (I’ll refer to these schemes below simply as WPA).

1. There is not a good case for using WPA to deal with exceptionally high unemployment, e.g. the exceptionally high unemployment that occurs in a recession. That is, there is no case for using WPA to deal with “above NAIRU” unemployment. This is not to say that WPA should not operate during a recession. The point is that the cure for EXCESSIVELY HIGH unemployment is to raise demand.

2. The unemployed tend to be unskilled. This is for two reasons. First, employers tend to pick the best labour first. Second, even if the quality of unemployed labour were the same as that making up those in work, a problem would still arise as unemployment falls: it would become increasingly difficult to match available skills to vacancies. That is, given low unemployment, there is a good chance that the only job an unemployed individual can do, even if they have skills, will be an unskilled job.

3. The relatively unskilled labour on WPA schemes needs other factors of production: e.g. permanent skilled supervisory labour, capital equipment and materials. If WPA labour has no other factors of production (OFP), output will be hopeless. On the other hand of OFP levels rise to anything like those obtaining with normal employers, then the WPA scheme becomes indistinguishable from a normal employer. Thus WPA is stuck between a rock and a hard place.

Incidentally this “indistinguishability” feature was evident in the 1930s WPA: that is some WPA construction projects were indistinguishable from normal construction industry contractors in that the WPA schemes employed cranes, concrete mixers, carpenters, bricklayers, etc just like ordinary contractors. In contrast, some WPA schemes employed relatively little OFP, which resulted in hopelessly low output levels. Hence the nickname that the 1930s WPA acquired: “we piddle around”.

4. If unemployment is at NAIRU, WPA cannot take permanent skilled supervisory labour from the existing economy because the latter is already working at capacity. Put another way, if the latter OFPs are nicked from the existing economy, inflation ensues. Alternatively, if aggregate demand is reduced so as to prevent the inflationary effect of “OFP nicking”, this means that WPA jobs are being created AT THE EXPENSE OF normal jobs: hardly the object of the exercise.

5. Conclusion: there is no logical niche for WPA. That is a very negative conclusion.

Having reduced WPA to rubble, I’ll try to show how to build something from the rubble in a day or two.

Thursday, 21 January 2010

There is a widespread view that unemployment cannot occur in barter economies. E.g. see the quote from Prof Paul Davidson at the top of this site. Plus see here. And see here (12th para – starting “MMT tells us....”.)

Barter economies certainly cannot suffer from the “paradox of thrift” cause of unemployment. But they could still experience unemployment if the relative price of different products was not flexible enough. Here is whey.

Consider what Robinson Crusoe does on arriving on a desert island where there are about five families and a barter economy. And let’s assume just three products: fish to eat, grass skirts to wear and mud huts to live in.

Crusoe is good at fishing, so he goes fishing and offers fish in exchange for a hut and a skirt. The additional supply of fish provided by Crusoe won’t be a problem as long as the price of fish falls in terms of huts and skirts. However if there is NOT price flexibility, Crusoe will not be able to sell his fish. He will be unemployed (or someone else who specialises in fishing will be unemployed).

Exactly the same problem occurs in money using economies: wages are “sticky downwards” as Keynes pointed out. That is, given an excess supply of a particular type of labour, the price of that type of labour will not fall, or at least will fall far too slowly to avoid unemployment for some members of the type of labour concerned. (Arguably Keynes was not referring in his “sticky downwards” point to SPECIFIC types of labour, but rather to labour in the aggregate, but never mind.)

The relative price of different types of labour is probably MORE flexible in barter economies than in money economies, but it is unlikely that prices are PERFECTLY flexible in barter economies.

To summarise, on purely theoretical grounds, barter economies seem to have significant advantages over money economies when it comes to unemployment. But unemployment is not impossible in barter economies.

Afterthought (25th Jan):

Thanks to an idea put by Tim Hickey (see below), I would now like to state the “Musgrave/Hickey General Theory of Unemployment In Barter Economies”, which is thus.

1. In ultra simple economies, that is where there is no specialisation or “division of labour” as economists call it, unemployment is almost impossible. The only possible cause would be a severe shortage of natural resources. E.g. in a drought people might not be able to grow food.

2. Given division of labour, a possible cause of unemployment arises, namely insufficient flexibility in the relative price of different types of labour and products.

3. When an economy gets even more “sophisticated” and introduces money, another possible cause of unemployment arises: the well known “paradox of thrift”.

Tuesday, 19 January 2010

Half the world has gone mad about home insulation as a “job creation” measure to beat the recession. Unfortunately even J.K.Galbraith, one of Obama’s economic advisors, has got the home insulation bug.

Why home insulation should be a better job creator than the thousand and one other products and services that modern economies offer is a mystery. Presumably one argument is that we “need” better home insulation. True, but as it points out in chapter one of the basic economics text books, humanity’s “needs” (and greed) are almost infinite. There are an infinite number of things we “need” more of.

Of course it could well be that the market undervalues home insulation (in view of global warming, for example). But this is an argument for a PERMANENT subsidy of home insulation. It is not an argument for a sudden and temporary expansion in home insulation, presumably followed by an equally sudden contraction in this sector once the recession is over.

Rather than boost demand for one or two specific products, why not just boost demand for ALL products? One good reason for the latter policy is that if a country concentrates on a relatively small number of products to boost, its domestic economy will not be able to cope with the sudden increase in demand for the relevant materials. This is exactly what happened in Australia: most of the additional home insulation material was imported, i.e. many of the jobs were created outside Australia.

Having criticised Galbraith above, he does at least redeem himself when he says “First, there is no excuse for a single layoff in the state and local public sector”. Quite right. If there is one thing it should be EASY for any government to do (especially a government that issues its own currency) it is to avoid sacking any public sector librarians, street sweepers and so on.

Sunday, 17 January 2010

Keynes’s big idea was that in a recession, governments should borrow more and spend more.

The major, and widely recognised potential weakness in this idea is “crowding out”. That is the fact that if government raises interest rates with a view to attracting funds to borrow and spend (B & S), this may simply reduce borrowing and spending by the private sector. That is the net effect of B & S could be zero.

In short, employing B & S is verging on the lunatic.

Far better would be to concentrate on interest rate reductions and/or on the part of B&S which is guaranteed to work, that is the “spend” part. I.e. why not just print money and spend it? (Actually "print and spend" will inevitably bring down interest rates).

The standard response of economic conservatives (and Tory Party members in the UK and Republicans in the US) is that money printing is inflationary. The answer to this is that money printing is not inflationary UNTILL such additional money results in additional demand.

David Hume in his essay “Of Money” written in 1752 recognised this when he said in reference to a money supply increase “if the coin be locked up in chests, it is the same thing with regard to prices as if it were annihilated”. The economic conservatives evidently have not learned much in 250 years.

The other daft aspect of B & S (which is perhaps just another way of re-stating a point made above) is that the objective of B & S is to stimulate or reflate an economy. In contrast, the “borrow” part of B & S is clearly deflationary. Now what on earth is the point of doing something which is DEFLATIONARY when the object of the exercise is REFLATION?

The purpose of pouring soap and water over a car is to clean it. Is there any point in throwing dirt over the car beforehand?

Of course “print and spend” is risky: the risk is that the relevant government and/or central bank fails to rein in the additional money when inflation looms. And Milton Friedman had a very good point when he said that governments are so hopeless at dealing with booms and recessions that it would be better if they did not try.

On the other hand, the political reality is that governments cannot stand by and do nothing when a serious recession, like the present one, occurs.

So given that governments are going to do something, it would be nice if they did something effective.

Moreover, the risks involved in B & S are much the same as those involved in print and spend. That is, B & S may prove more effective than anticipated, in which case excess inflation might ensue. Alternatively, B & S many be totally ineffective, in which case the result is arguably even worse: excess unemployment, poverty, homelessness and so on.

Another fatuous wheeze is printing astronomic quantities of extra money and handing it to banks who in turn just sit on it. Excess reserves at U.S. banks have always hovered around zero – until late 2008 when they shot up to around $800bn.

“It’s a disgrace to the economics profession that they haven’t figured out how to sustain demand when all it takes are a few spread sheet entries by govt. I could teach any third grader to do it in 15 minutes.”

Thursday, 14 January 2010

One of the sources of instability which exacerbated the credit crunch is the freedom that the private banking system has to create money. The commercial or private bank system tends to greatly expand its money creation activities exactly when it should not: in a boom. Plus the money creation system slows down or goes into reverse exactly when it shouldn’t: in a recession.

This ability of the private banking system to create and extinguish money stems from the fractional reserve system; and a solution to the problem would be full reserve banking (or perhaps 90% reserve banking). Full reserve is a system under which the only money is the “state’s money”, i.e. monetary base.

Milton Friedman advocated this system, and specifically so as to bring better stability. This was in a paper in the American Economic Review in 1948: “A Monetary and Fiscal Framework for Economic Stability”. There is also a small political party in the UK devoted to this end: the Monetary Reform Party. The latter quotes from various historical figures who advocated full reserve banking, e.g. Abraham Lincoln.

Friedman repeated his views in 1975 to a US House subcommittee (US House, 1975, 2156-57)

Full reserve is also advocated by a German academic: see paper by Claude Hillinger (p. 29).

Beware of the large number of nutters who advocate full reserve banking because they think that fractional reserve is some sort of fraud. The basic merit of full reserve is as set out by Milton Friedman: better stability.

Obviously were fractional reserve banking to be abolished, a much larger monetary base would be needed.

Equally obvious is the fact that if full reserve were seriously mooted, the goons and the cowboys running existing commercial banks would fight it tooth and nail. Banksters want casino type activity: so much more fun than providing boring old basic banking facilities for Mr and Mrs Boring Average.

And even better than casino type activity is casino type activity with taxpayers picking up the bill when things go wrong. Who can possibly object to a “heads I win, tails you lose” scenario?

Can fractional reserve be suppressed?

Fractional reserve banking is free market activity that arises naturally, thus the question arises as to how difficult it would be to suppress were it outlawed. For example would banks and/or non-bank institutions not still try to engage in “fractional” activities?

There are several answers. First, there is little temptation to create additional currency where the state already provides an adequate volume of currency. For example, take those very small scale currencies that individual towns sometimes create. There is only significant room for these currencies given significant unemployment. That is, if half the people in your neighbourhood are unemployed, they will (by the very definition of the word “unemployed”) be seeking to engage in some form of economic activity. Being unemployed, they will be short of conventional money. Solution: have the neighbourhood create its own money to help those in the neighbourhood trade with each other.

However, given full employment and an adequate supply of conventional money, there is little demand for some other form of money.

Second, fractional reserve systems nearly always involve a legal maximum “fraction”. That is banks have to keep some minimum by way of reserves (10% of loans and deposits, or whatever). This has never proved difficult to enforce. Thus if the fraction happens to be 100% rather than 10%, it is hard to see where the big problem is.

Third, it would be very difficult for small, back street, or non-bank institutions to get into the fractional reserve business in a big way. (And if any institution which did get into this activity in a big way would automatically come to the attention of the authorities).

Fractional reserve banking involves creating debt which is then passed from hand to hand in exchange for goods and services. Now if you are given a cheque drawn on a well known bank, you trust it ( assuming you also trust the person writing out the cheque). But suppose you live in the North of Scotland and the cheque is drawn on a “bank” recently set up by Joe Bloggs, the well known firm of plumbers in the east end of London (but unheard of in Scotland): would you trust it?

Isn’t better bank regulation superior to full reserve banking?

Could be. But the world economy has just take a multi trillion dollar hit as a result of poor bank regulation. And do we have better bank regulation as a result? I don’t think so.

Bank funded lobbyists are crawling all over Capitol Hill. Plus “better regulation” is inherently complicated, which means that banks will arguably always outwit politicians on this one.

The beauty of full reserve is that it is a nice simple rule, and as Milton Friedman makes clear, it is a substitute for a variety of detailed regulations: the legislative and bureaucratic costs are arguably lower.

Thursday, 7 January 2010

When Gordon Brown announced in October 2009 that he intended reducing the national debt by £16bn via the sale of public assets, my response was to point out that ten times that much could easily be wiped off this debt just by getting the Bank of England to shred the gilts in its possession.

“Not Very Gay Gordon” has obviously been reading this blog, because he has gone quite on the £16bn asset sale.

Anyway, this is an even better idea: let’s abolish the national debt! Here’s how.

First as regards the portion of the national debt held by foreigners, the UK holds about $200bn of US national debt. So we sell that and pay off the foreign holders of UK national debt.

As regards the rest, we just print the necessary amount of money and buy back the debt, or “quantitatively ease” it, if you want jargon.

Those who found themselves in possession of cash instead of gilts would NOT for the most part run out and spend it. Why were these people holding gilts? Because they wanted to save: they regarded said gilts as part of their stock of savings. Likewise, they would regard the cash that replaced their gilts as savings. Their initial response would be to dump the cash in a bank deposit account. Then some of the cash would tend to boost the price of other assets: housing, shares, etc.

Also, banks would find themselves in possession of additional funds which theoretically they could lend, and that would have a reflationary effect. But banks just aren’t lending very much at the moment: they have surplus funds sitting doing very little with central banks.

At any rate, the above wheeze would boost demand to some extent. If the boost was just sufficient to bring us back to full employment and no more, there would be absolutely no reason to worry about the somewhat expanded money supply.

On the other hand, if it looked as though demand was being boosted too much and causing inflation, then government would have to raise interest rates and raise taxes to pay for said interest payments.

But hang on. In order to effect the above interest rate rise, the “government – central bank machine” has to bid funds away from the private sector: that’s HOW it effects the interest rate rises that it announces from time to time. Does the latter not amount, at least to some extent, to re-creating the national debt? The answer is “not really” – and for the following reasons.

Note that PURPOSE of the above “bidding away from the private sector” is NOT to fund government spending. The PURPOSE is to effect a deflationary stance, i.e. raise interest rates and taxes. That is, the PURPOSE is simply to confiscate money from the private sector and shred it. Obviously the capital sum “borrowed” will have to be paid back, though that could be after a number of years by which time inflation will have eroded its value.

To summarise, two forms of shredding take place here. 1, government grabs more tax with which to pay the above interest, and 2, the value of the above capital sum is eroded.

“Government – central bank machines” can print money. They can equally well do the opposite: shred it.

This might appear to involve some sort of cost or loss of real wealth for the private sector. That is debatable. All that happens is that government confiscates money which were it to be spent would cause excess inflation. That is, it confiscates money which the private sector could not effectively spend if it wanted to. So in what sense is this money a form of wealth?

Finally, it should be said that ideas of the type set out here were first set out by Abba Lerner. And as Keynes said to James Meade in 1943: “Lerner's argument is impeccable, but heaven help anyone who tries (to) put it across to the plain man at this stage of the evolution of our ideas."

Those interested in these ideas should Google “Modern Monetary Theory” and “Abba Lerner”.

The above national debt abolition plan would not work quite as smoothly as set out above. There are a number of problems and potential hitches, but they are minor hitches and are surmountable.

Tuesday, 5 January 2010

Those who advocate immigration would do themselves a big favour if they spent more time studying the subject before opening their mouths.

For the umpteenth time in as many months an article has just appeared in one of the UK broadsheet newspapers (The Times) claiming that immigrants can solve or help solve our ageing population problem.

The flaw here is that immigrants themselves grow old (would you credit it?). Thus this policy requires a never ending exponential population increase, and the extent of this increase is staggering. One study estimates that a twenty five fold increase over a hundred years would be needed. That is what I call a reductio ad absurdum. (See 2nd last para, p. 24 here.)

One possible escape from this absurdity is to claim that while it would be nonsensical to use immigration alone to deal with the ageing population problem, a little immigration can at least help. This is a bit like arguing that while it is daft to burn one’s furniture to keep the house warm, nevertheless it could makes sense to burn just a little furniture each day.

Well thanks, but I’ve no intention of burning my furniture (not even a little at a time).

England already has more people per square kilometre than China (though if one includes Scotland and Wales it works out at a slightly lower population density than China).

And to add insult to injury, the Chinese have just realised that their laudable “one child per family” policy will bring them the same ageing problem, but quicker than would otherwise be the case.

But I know the solution to that: people migrating from England to China!

Monday, 4 January 2010

I am grateful to Robert Hahl for drawing my attention to the new currency or quasi-currency: kilowatt hour tokens.

This unit of currency is the same the world over – indeed it’s the same the universe over. Inflation cannot erode its value. Though if someone invented some ultra cheap source of power, this currency would lose its value somewhat. But this is unlikely to happen. Like gold, power is a universally accepted commodity. It’s the perfect currency.

This idea is original and humorous. It’s ideas like this that can cause ostensibly more sophisticated ideas to come crashing down. I don’t think kilowatt hour tokens will drive other currencies out of business, but this is a cute idea and merits some thought.

Sunday, 3 January 2010

Deflation horror stories were all the rage a month or two ago, but seem to have subsided. Fashions change so quickly.

Of course these deflation horror stories for the most part failed to distinguish two entirely different meanings of the word deflation: 1, falling prices, and 2, inadequate demand (i.e. excess unemployment). At any rate, where the distinction was made, it seems that falling prices were in themselves a precursor to the end of civilisation as we know it. I never lost any sleep over this.

In the US between 1866 and 1897 output rose by 4% a year while prices fell by 2% a year according to an article by Samuel Brittan in the Financial Times. The sky didn’t fall in the US in these years did it? And what is wrong with an output rise of 4% a year?

And in the UK between 1870 and 1896, wholesale prices fell by 50 per cent, while Britain’s economy also grew by 4 per cent each year, according to an article by Ian King in The Times. Was the sky in a state of permanent “fall in” in this period in the UK? I don’t think so.

Saturday, 2 January 2010

The following passage is taken from “Functional finance and the US government budget surpluses in the new millennium” by L. Randall Wray, Professor, University of Missouri—Kansas City.

According to President Clinton's 1999 and 2000 State of the Union addresses, we are on a course to run federal government budget surpluses for the next 15 to 25 years. On current projections, these surpluses are so large that all the publicly held debt of the US government would be completely eliminated by 2015.

The President actually proposed that some portion of the surplus be “set aside” to be held in Social Security trust funds. For example, if a budget surplus of $100 billion were to accrue in one particular year, $100 billion worth of government bonds held by the public would be retired, while perhaps $60 billion worth of new government debt would be created to be held in the trust fund. This would be described as “saving” 60% of the budget surplus to be used later when baby boomers retire.

The President’s analyses have been well received. A number of prominent economists, including at least six Nobel winners circulated an open letter after the 1999 State of the Union address dubbing the president's plan "good economics" and stating that "Although no one can predict how large the budget surpluses will turn out to be, we can be sure that saving them by reducing outstanding government debt is an excellent way to ease the burden on future workers of supporting an aging population."

Lawrence Summers, now Secretary of the Treasury, and Janet Yellen, chair of the President's Council of Economic Advisers, assured us that the president's proposal to "lock away" most of the projected budget surpluses in the Social Security Trust Fund is based on "sound accounting" and that it will extend Social Security's solvency through 2055.

David Broder's Washington Post article (February 7, 1999) proclaimed the plan to be "the greatest gift to our children" because it will "help grow the economy" by "raising national savings."

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

______________

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Bits and bobs.

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The Swiss Sovereign Money movement.

The bank subsidy no one mentions.

I can see the point of making accounts at a country’s central bank available to all, and in having that run on block chain / crypto lines (if that’s the most efficient way of operating those accounts). Accounts with the central bank / government have essentially been available to Brits for decades in the form of accounts at National Savings and Investments. Block chain / crypto could make that more efficient.But what’s the point of an OFFICIAL crypto currency where the units are liable to quaduple in value (like Bitcoin) and then crash?

________

Study puts the value of the Too Big To Fail subsidy for large Canadian banks at around $1.6billion a year for each bank. And what do the regulators and their cronies in the bank industry do? Mumble into their beards, look the other way, and try to sweep the whole thing under the carpet. (hat tip to Stephanie Schulte)________

The first two sentences of Simon Wren-Lewis’s latest article (15th March) made me laugh:

"I was not going to write anything about the non-event of Hammond’s Spring statement, in part because I confess I am tired of writing about the Conservative party’s hopeless macroeconomic policy. It is like being forced to second mark all the fails from a first year economics exam."________

Larry Kudlow is Trump’s new economic advisor. In Dec. 2007 just before the worst recession since the Great Depression, Kudlow said: “There’s no recession coming. The pessimistas were wrong. It’s not going to happen...The Bush boom is alive and well.” Well that bodes well doesn’t it?

But all is not lost. Cheer up! Trump normally sacks those he has appointed a month after appointing them.....:-) ________

Simon Wren-Lewis (Oxford economics prof) does another article in which he expresses interest in MMT.________

It is precisely the fact that private banks are allowed to create or print money that causes bank failures.

Money is a short term liability of a bank. So if banks can create money, they can engage in “borrow short and lend long”, which is what causes bank failures. But that risky method of money creation is totally unnecessary because central banks can supply the economy with whatever amount of money is needed to bring full employment, and all without the above attendant risk.________

Mark Carney, governor of the Bank of England is not impressed by crypto currencies.________

The Fed implemented QE, which is supposed to have a stimulatory effect, at the same time as paying interest on reserves, which has the opposite effect, i.e. a deflationary effect. Unless I’m much mistaken, that equals schizophrenia.________

Nice article in the Financial Times today entitled “George Osborne austerity target is hit…”. The FT seems enthusiastic about the “austerity target” having been hit. I quite agree. I’m looking forward to women being sent down coal mines, young boys being sent up chimneys to clean them, and the re-introduction of Victorian slums (ho ho).

More seriously, the article shows no understanding of Keynes's point that the deficit / surplus needs to be whatever brings full employment without too much inflation. I.e. deficits are not inherently undesirable, and (contrary to the FT's suggestions) surpluses are not inherently desirable._________

Long time ago, oil companies knew that global warming would change the climate, and adjusted the design of their oil rigs and pipe-lines to suit. They then denied the existence of global warming. Don’t you just love it?________

Wall Street crooks manage to roll back stricter regulation and return to the good old "heads we win, tails the taxpayer loses" arrangement. Meanwhile politicians are way too dumb to know what's going on, and anyway their pockets will have been stuffed with wads of dollar bills to make sure they “see sense”.________

Total fines and out of court settlements paid by US banks (since the 2007 crisis I assume) now stands at $243bn.________

Laugh of the day: Mark Carney tells bankers they should not aim to earn loads of money but should aim to “promote……prosperity in the wider society”. ________

Sarah Bedford of the New Economics Foundation claims output of immigrants in the UK is £17million per day. Least that’s what she SEEMS to be saying: it’s not actually 100% clear what she's saying. Anyway assuming my interpretation of her work is right then…. let’s import the entire population of China: then the "output of immigrants" would be a HUNDRED TIMES more!!!!________

I do like Stephanie Kelton’s MMT colouring book. Filling in the colours should be a compulsory for all those with mental ages below three - i.e. all those under three, and all politicians over the age of three -….:-)________

90% of Euro banknotes issued in Germany are never spent: they’re just hoarded!!!!________

Thinking aloud….free banking (advocated by George Selgin and others) comes to the same thing as full reserve banking, seems to me. Reason is that under free banking there is no deposit insurance, thus deposits at banks are essentially equity: so called “depositors” stand to lose their shirts just like shareholders. At the same time, under free banking, depositors who want total safety are presumably free to deposit money at state run savings banks like National Savings and Investments in the UK. And that is effectively full reserve banking: loans are funded via equity, while no risks whatever are taken with deposits that are supposed to be totally safe.________

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MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A